//.TV  6  try 


United   States   District  Court 

Southern  District  of  New  York 


MYRTLE  H.  MACOMBER, 

Plaintiff, 
against 

MARK  EISNER,  as  Collector  of  United  States 
Internal  Revenue  for  the  Third  District  of 
the  State  of  New  York, 

Defendant. 


BRIEF  FOR  THE  PLAINTIFF. 


Statement  of  the  Case. 

The  case  is  heard  on  complaint  and  demurrer. 
The  action  is  brought  to  recover  a  tax  collected  under 
the  Income  Tax  Law  of  191 6  on  the  ground  that  it 
was  illegally  assessed.  The  facts  are  fully  set  out  in 
the  complaint ;  briefly  they  are  as  follows : 

On  January  1st,  191 6,  the  Standard  Oil  Company 
of  California  had  capital  stock  issued  and  outstanding 
to  the  amount  of  $49,686,656.  On  that  date  the  Com- 
pany had  surplus  and  undivided  profits,  which  were  in- 
vested in  its  plant,  property  and  business  required  for 


•  v  : 


the  purposes  of  the  Company,  amounting  to  $44,852,- 
263.02.  Of  this  sum  $20,353,068.34  had  been  earned 
prior  to  March  1st,  19 13,  and  the  balance,  $24,499,- 
194.68,  subsequent  to  that  date  (fols.  3,  4,  5).  On 
January  16th,  191 6,  the  Directors  declared  a  'stock  divi- 
dend' of  $24,843,327.74,  to  be  issued  to  the  shareholders 
on  a  ratio  of  half  a  new  share  to  one  old  share.  Pur- 
suant to  this  resolution  all  of  the  surplus  earned  before 
March  1st,  19 13,  was  transferred  from  surplus  account 
to  capital  stock  account  and  sufficient  of  the  remaining 
surplus  to  equal  the  balance  of  the  par  value  of  the  new 
shares  (fol.  7).  As  a  result  18.0743  per  cent,  of  the 
par  value  of  the  new  shares  represented  earnings  sub- 
sequent to  March  1st,  19 13  (fol.  12). 

The  plaintiff,  owning  2,200  shares  previous  to 
January  1st,  19 16,  received  1,100  of  these  new  shares 
(fol.  8).  The  defendant,  acting  under  the  authority 
of  the  Treasury  Department  and  the  Act  of  Congress 
of  September  8th,  19 16,  levied  a  tax  on  the  plaintiff 
as  having  received  income  of  $19,877,  being  18.07  per 
cent,  of  $110,000,  the  par  value  of  the  new  shares 
(fols.  15,  16,  17,  18).  The  tax  was  paid  under  pro- 
test and  appeal  taken  to  the  Commissioner  of  Internal 
Revenue,  which  appeal  having  been  disallowed,  plain- 
tiff brought  this  action  to  recover  the  money  so  paid. 

The  complaint  also  states  that  prior  to  the  closing 
of  the  books  for  the  distribution  of  the  'stock  dividend', 
sales  of  the  Company's  stock  were  made  in  the  open 
market  at  prices  ranging  from  $360  to  $382  per  share, 
and  that  subsequent  thereto  the  prices  ranged  from 
$234  to  $268  a  share  (fol.  10).  These  figures  show 
that  the  market  value  of  plaintiff's  holdings  was  prac- 


3 

tically  unchanged  by  the  action  of  the  directors,  two 
of  the  parent  shares  being  equivalent  to  three  subse- 
quent to  the  distribution. 

The  issue  of  law  presented  in  this  case  is  whether 
Congress  has  power  to  include  in  the  amount  for 
which  an  individual  is  liable  under  the  Income  Tax 
Law  of  1 91 6,  the  "cash  value"  of  new  shares  which 
are  received  upon  the  declaration  of  a  'stock  dividend'. 

The  complaint  alleges  that  such  a  tax  is  in  viola- 
tion of  Article  I,  Section  3,  clause  3,  and  Article  I, 
Section  9,  clause  4,  of  the  Constitution  requiring  that 
direct  taxes  be  apportioned  according  to  population, 
and  that  it  is  not  included  within  the  provisions  of  the 
Sixteenth  Amendment  permitting  the  taxation  of 
"incomes"  without  apportionment. 

The  applicable  parts  of  the  Income  Tax  Law  of 
191 6  are  found  in  39  Stat.  756,  Ch.  463,  Part  I,  Sec- 
tion 1  (b)  : 

"In  addition  to  the  income  tax  imposed  by 
subdivision  (a)  of  this  Section  (herein  refer- 
red to  as  the  Normal  Tax)  there  shall  be  levied, 
assessed,  collected  and  paid  upon  the  total  net 
income  of  every  individual  or  in  the  case  of  a 
non-resident  alien  the  total  net  income  from  all 
sources  within  the  United  States,  an  additional 
income  tax.    .      .    ." 

Section  2  (a) 

"The  net  income  of  the  taxable  person  shall 
include  gains,  profits  and  income  derived  from 
salaries,  wages  or  compensation  for  personal 
service  of  whatever  kind  and  in  whatever  form 
paid,    or    from    professions,    vocations,    busi- 


568105 


nesses,  trades,  commerce  or  sales,  or  dealings 
in  property,  whether  real  or  personal,  growing 
out  of  the  ownership  or  use  of  or  interest  in 
any  real  or  personal  property,  also  from  inter- 
est, rent,  dividends,  securities,  or  the  transac- 
tion of  any  business  carried  on  for  gain  or 
profit,  or  gains  or  profits  and  income  derived 
from  any  source  whatever;  Provided,  that  the 
term  'dividends'  as  used  in  this  title  shall  be 
held  to  mean  any  distribution  made  or  ordered 
to  be  made  by  a  corporation,  joint-stock  com- 
pany, association  or  insurance  company  out  of 
its  earnings  or  profits,  accrued  since  March 
first,  nineteen  hundred  and  thirteen,  and  pay- 
able to  its  shareholders,  whether  in  cash  or  in 
stock  of  the  corporation,  joint-stock  company, 
association,  or  insurance  company,  which  stock 
dividend  shall  be  considered  income,  to  the 
amount  of  its  cash  value." 

There  was  considerable  doubt  about  the  meaning 
of  the  term  "cash  value"  which  was  interpreted  by  the 
collector  to  mean  in  the  present  case  "par  value". 
This  is  plainly  an  arbitrary  figure,  for  the  complaint 
admits  that  any  share  was  worth  from  $234  to  $268 
subsequent  to  the  readjustment. 

The  War  Revenue  Act  of  October  3,  191 7,  40  Stat. 
300,  Ch.  63,  Section  12,  amends  the  above  to  read: 

"which  stock  dividends  shall  be  considered  in- 
come to  the  amount  of  the  earnings  or  profits 
so  distributed" 

but  this  change  of  course  does  not  affect  the  present 
case,  which  is  concerned  solely  with  income  under  the 
Act  of  19 1 6. 


POINT  I. 

THE  TAX  IS  SOUGHT  TO  BE  LAID  UPON  THE  PROPERTY 
IN  QUESTION  SOLELY  BY  REASON  OF  OWNERSHIP 
AND  CANNOT  BE  SUSTAINED  UNLESS  IT  IS  AUTHOR- 
IZED BY  THE  SIXTEENTH  AMENDMENT. 

Before  the  Sixteenth  Amendment  there  were  two 
kinds  of  income  with  respect  to  taxability  under  the 
Federal  Constitution. 

(a)  Gains  and  profits  from  "Business,  priv- 
ileges, employments,  and  vocations"  whether  of 
corporations  or  of  individuals. 

Pollock  v.  Farmers'  Loan  &  Trust  Co.,  158 
U.  S.  601,  637. 

A  tax  upon  such  gains  and  profits  was  an  excise 
subject  to  the  constitutional  requirement  as  to  geo- 
graphical uniformity. 

Pollock  v.  Farmers'  Loan  &  Trust  Co.,  158 

U.  S.  601,635; 
Brushaber  v.  Union  Pacific  R.  R.  Co.,  240 

U.  S.  1. 
Stanton  v.  Baltic  Mining  Co.,  240  U.  S.  103. 

The  Corporation  Tax  Act  of  1909  fell  within  this 
category. 

Fint  v.  Stone  Tracy  Co.,  220  U.  S.  107. 
Stratton's  Independence,  Ltd.,  v.  Howbert, 

231  U.  S.  399. 
Doyle  v.  Mitchell,  Bros.  Co.,  247  U.  S.  179, 

182,  183. 
Hays  v.  Gauley  Mountain  Coal  Co.,  247  U.  S. 
189,  191,  192. 


6 

(b)  Income  from  real  or  personal  property, 
as  such,  taxed  by  reason  of  ownership. 

A  tax  upon  such  income  is  not  an  excise,  but  a 
direct  tax.  The  question  involved  in  the  Pollock  case 
related  to  this  sort  of  income,  and  it  was  held  that  as 
the  tax  was  a  direct  tax,  Congress  had  no  constitu- 
tional power  to  impose  it  without  the  required  appor- 
tionment among  the  States  (according  to  population 
(Const.,  Art.  I,  Sees.  2  and  9). 

In  the  case  at  bar,  we  are  concerned  solely  with 
this  direct  tax. 

"Direct  taxes",  which  are  within  the  restriction  of 
Article  I,  Sees.  2  and  9,  include  not  only  capitation 
taxes  and  taxes  upon  lands,  houses,  and  other  real 
property,  but  also  all  taxes  on  personal  property  or 
investments,  including  income  from  either  real  or  per- 
sonal property,  taxed  because  of  ownership.  Taxes 
on  investments  in  corporate  stocks,  laid  directly  be- 
cause of  ownership,  are  in  this  class. 

Pollock  v.  Farmers'  Loan  &  Trust  Co.,  158 
U.  S.  601,  637. 

The  Sixteenth  Amendment  removed  the  require- 
ment of  apportionment  only  in  the  case  of  taxes  on 
incomes.    It  provides: 

"The  Congress  shall  have  power  to  lay  and 
collect  taxes  on  incomes,  from  whatever  source 
derived,  without  apportionment  among  the  sev- 
eral States,  and  without  regard  to  any  census  or 
enumeration." 

The  history  of  this  Amendment  is  well  known.  It 
was  adopted  for  the  purpose  of  avoiding  the  effect  of 


the  decision  in  the  Pollock  case,  and  of  permitting  Con- 
gress to  levy  a  tax  on  incomes  without  apportionment. 
Taxes  on  "income"  from  whatever  source  derived  were 
thus  placed  in  the  same  category  and  could  be  levied 
without  apportionment,  being  subject  in  the  same  man- 
ner as  excises  to  the  constitutional  requirement  as  to 
geographical  uniformity. 

Brushaber  v.  Union  Pacific  R.  R.  Co.,  240 
U.  S.  pp.  18,  19. 

The  sole  question,  therefore,  is :  What  is  "income"  ? 

There  is  nothing  in  the  Sixteenth  Amendment 
which  authorizes  Congress  to  levy,  without  apportion- 
ment, a  tax  on  anything  which  does  not  come  within 
the  proper  definition  of  "income".  It  was,  obviously, 
not  the  intention  to  authorize  Congress  to  levy  a  direct 
tax  on  property,  except  as  to  income,  or  otherwise  to 
amend,  to  qualify,  or  in  any  way  to  restrict  the  require- 
ments which  have  existed  ever  since  our  Constitution 
was  adopted,  that  direct  taxes  on  property  can  be  levied 
by  Congress  only  if  properly  apportioned  among  the 
States. 

In  some  of  the  five  cases  involving  questions  under 
the  Income  Tax  Section  of  the  19 13  Tariff  Law,  re- 
ported in  240  U.  S.,  pp.  1-26;  103-126,  the  limitations 
of  Article  I,  Sections  2  and  9,  of  the  Constitution,  re- 
quiring that  direct  taxes  be  apportioned,  were  urged  as 
restricting  certain  operations  of  the  law  with  respect  to 
the  facts  in  the  cases  before  the  Court,  and  the 
Supreme  Court  sustained  the  law  as  against  the  con- 
tentions there  urged.  In  none  of  them,  however,  was 
the  present  question  presented. 

In  Stanton  v.  Baltic  Mining  Co.,  240  U.  S.  103,  the 


8 

question  related  to  the  tax  on  mining  corporations,  and 
it  was  found  that  the  tax  there  under  consideration 
was  not  "a  tax  upon  property  as  such,  because  of  its 
ownership",  but  like  the  tax  considered  in  Stratton's 
Independence,  Ltd.,  v.  Howbert,  supra,  was  a  "true 
excise",  levied  on  the  results  of  the  business  of  the  cor- 
poration, "in  carrying  on  mining  operations". 

That  any  attempt  under  the  guise  of  an  income  tax 
law  to  levy  an  unapportioned  direct  tax  on  real  or  per- 
sonal property  could  not  be  sustained  is  evident  from 
the  statements  in  the  opinion  of  the  Supreme  Court 
delivered  by  the  Chief  Justice  in  the  Brushaber  case  at 
pages  18,  19: 

"the  whole  purpose  of  the  amendment  was 
to  relieve  all  income  taxes  when  imposed  from 
apportionment  from  a  consideration  of  the 
source  whence  the  income  was  derived  .  .  . 
it  was  drawn  with  the  object  of  maintaining  the 
limitations  of  the  constitution  and  harmonizing 
their  operation.  We  say  this  because  it  is  to  be 
observed  that  although  from  the  date  of  the 
Hylton  case  because  of  statements  made  in  the 
opinions  in  that  case  it  had  come  to  be  accepted 
that  direct  taxes  in  the  constitutional  sense  were 
confined  to  taxes  levied  directly  on  real  estate 
because  of  its  ownership,  the  Amendment  con- 
tains nothing  repudiating  or  challenging  the 
ruling  in  the  Pollock  case  that  the  word  direct 
had  a  broader  significance  since  it  embraced  also 
taxes  levied  directly  on  personal  property  be- 
cause of  its  ownership,  and  therefore  the  amend- 
ment at  least  impliedly  makes  such  wider  sig- 
nificance a  part  of  the  Constitution — a  condi- 
tion which  clearly  demonstrates  that  the  pur- 
pose was  not  to  change  the  existing  interpreta- 


tion  except  to  the  extent  necessary  to  accom- 
plish the  result  intended,  that  is,  the  prevention 
of  the  resort  to  the  sources  from  which  a  taxed 
income  was  derived  in  order  to  cause  a  direct 
tax  on  the  income  to  be  a  direct  tax  on  the 
source  itself  and  thereby  to  take  an  income  tax 
out  of  the  class  of  excises,  duties,  and  imposts 
and  place  it  in  the  class  of  direct  taxes." 

Again,  in  Stanton  v.  Baltic  Min.  Co.,  (supra)  Mr. 
Chief  Justice  White  said  (p.  113)  : 

"We  are  here  dealing  solely  with  the  re- 
striction imposed  by  the  Sixteenth  Amend- 
ment on  the  right  to  resort  to  the  source 
whence  an  income  is  derived  in  a  case  where 
there  is  power  to  tax  for  the  purpose  of  taking 
the  income  tax  out  of  the  class  of  indirect  to 
which  it  generically  belongs  and  putting  it  in 
the  class  of  direct  to  which  it  would  not  other- 
wise belong  in  order  to  subject  it  to  the  regula- 
tion of  apportionment." 

Finally,  the  Court  said,  referring  to  the  Sixteenth 
Amendment,  "As  pointed  out  in  recent  decisions,  it 
does  not  extend  the  taxing  power  to  new  or  excepted 
subjects,  but  merely  removes  all  occasion,  which  other- 
wise might  exist,  for  an  apportionment  among  the 
States  of  taxes  laid  on  Income",  per  Mr.  Justice  Van 
Devanter,  Peck  v.  Lowe,  247  U.  S.  165,  172. 

See  also,  Southern  Pacific  Co.  v.  Lowe,  247 
U.  S.  330,  335. 

The  doctrine  of  the  Pollock  case  remains  the  law 
of  the  land,  except  so  far  as  a  tax  on  "income"  has 


10 

been  removed  through  the  Constitutional  Amendment 
from  the  application  of  that  doctrine. 

It  is  also  apparent  that  there  was  no  intention  to 
authorize  Congress  to  coin  at  will  definitions  of  "in- 
come" and  prescribe  that  something  which  is  not,  in 
any  true  sense  of  the  word,  income  shall  be  income  for 
the  purposes  of  taxation.  Congress  cannot  by  legis- 
lative fiat  put  a  subject  of  a  tax  in  a  different  category 
from  that  in  which  it  properly  belongs,  for  that  would 
be  to  subject  the  constitutional  restrictions  to  the  leg- 
islative will. 

What  constitutes  income  is  exclusively  a  matter 
for  determination  of  the  courts. 

In  the  present  case  there  is  no  room  for  disputing 
the  fact  that  the  tax  is  levied  upon  property  solely  by 
virtue  of  its  ownership.  The  Standard  Oil  Company 
of  California  had  paid  its  excise  tax  under  the  Cor- 
poration Tax  Act  of  1909  and  its  income  tax  under 
the  Income  Tax  Laws  of  19 13  and  19 16.  There  is  no 
pretense  here  that  the  present  tax  is  laid  upon  the 
corporation,  or  by  reason  of  any  privilege  or  business 
of  the  corporation.  The  tax  is  levied  upon  the  in- 
dividual stockholder's  income,  simply  because  of  his 
ownership  of  the  stock  in  question.  The  tax  upon  the 
stock  by  virtue  of  the  stockholder's  ownership  is,  in 
the  very  nature  of  things,  a  direct  tax  which  must  be 
apportioned  unless  it  can  be  said  that  this  stock,  issued 
in  the  circumstances  we  have  stated,  is  income  within 
the  meaning  of  the  Sixteenth  Amendment.  It  is  our 
contention  that  it  is  not. 


11 


POINT  II. 

THE  DECISION  IN  TOWNE  v.  EISNER,  245  U.  S.  418,  WAS 
NOT  BASED  UPON  THE  GROUND  THAT  THE  SURPLUS 
UNDERLYING  THE  'STOCK  DIVIDEND'  WAS  ACCUMU- 
LATED PRIOR  TO  MARCH  1,  1913,  BUT  UPON  THE 
GROUND  THAT  THE  'STOCK  DIVIDEND'  WAS  ESSEN- 
TIALLY NOT  INCOME. 

In  Towne  v.  Bisner,  the  shares  of  stock  constituting 
the  'stock  dividend'  were  issued  in  the  year  1914  under 
a  corporate  resolution  adopted  in  December,  1913. 
The  Supreme  Court  based  its  decision  squarely  upon 
the  proposition  that  the  'stock  dividend'  was,  in  its  na- 
ture, not  income.  The  ruling  did  not  proceed  upon  the 
ground  that  the  surplus,  which  was  subsequently  capi- 
talized, had  been  accumulated  before  March  1,  191 3. 
It  is  manifest  that  the  reasoning  of  the  Court  would 
have  required  exactly  the  same  conclusion  if  the  sur- 
plus in  that  case  had  been  accumulated  after  March  1, 
1913.  In  delivering  the  opinion  of  the  Court,  Mr. 
Justice  Holmes  said  (pp.  426-427)  : 

"Notwithstanding  the  thoughtful  discussion 
that  the  case  received  below  we  cannot  doubt 
that  the  dividend  was  capital  as  well  for  the  pur- 
poses of  the  -Income  Tax  Law  as  for  distribu- 
tion between  tenant  for  life  and  remainderman. 
What  was  said  by  this  court  upon  the  latter 
question  is  equally  true  for  the  former.  'A 
stock  dividend  really  takes  nothing  from  the 
property  of  the  corporation,  and  adds  nothing 
to  the  interests  of  the  shareholders.  Its  prop- 
erty is  not  diminished,  and  their  interests  are 
not  increased  ....    The  proportional  inter- 


12 


est  of  each  shareholder  remains  the  same.  The 
only  change  is  in  the  evidence  which  represents 
that  interest,  the  new  shares  and  the  original 
shares  together  representing  the  same  propor- 
tional interest  that  the  original  shares  repre- 
sented before  the  issue  of  the  new  ones'.  Gib- 
bons v.  Mahon,  136  U.  S.  549,  559,  560.  In  short, 
the  corporation  is  no  poorer  and  the  stockholder 
is  no  richer  than  they  were  before.  Logan  County 
v.  United  States,  169  U.  S.  255,  261.  If  the 
plaintiff  gained  any  small  advantage  by  the 
change,  it  certainly  was  not  an  advantage  of 
$417,450,  the  sum  upon  which  he  was  taxed.  It 
is  alleged  and  admitted  that  he  receives  no  more 
in  the  way  of  dividends  and  that  his  old  and 
new  certificates  together  are  worth  only  what 
the  old  ones  were  worth  before.  If  the  sum 
had  been  carried  from  surplus  to  capital  ac- 
count without  a  corresponding  issue  df  stock 
certificates,  which  there  was  nothing  in  the  na- 
ture of  things  to  prevent,  we  do  not  suppose 
that  any  one  would  contend  that  the  plaintiff 
had  received  an  accession  to  his  income.  Pre- 
sumably his  certificate  would  have  the  same 
value  as  before.  Again,  if  certificates  for 
$1,000  par  were  split  up  into  ten  certificates 
each,  for  $100,  we  presume  that  no  one  would 
call  the  new  certificates  income.  What  has  hap- 
pened is  that  the  plaintiff's  old  certificates  have 
been  split  up  in  effect  and  have  diminished  in 
value  to  the  extent  of  the  value  of  the  new." 

This  language  is  unequivocal,  but  the  conclusion  to 
be  drawn  from  it  that  the  decision  had  been  based 
solely  upon  the  nature  of  the  'stock  dividend'  and  not 
upon  the  time  when  the  surplus  was  accumulated,  is 


13 


put  beyond  any  possible  question  by  the  later  decisions 
of  the  Supreme  Court. 

Thus,  in  Lynch  v.  Hornby,  24.J  U.  S.  339,  there  had 
been  a  distribution  of  dividends  by  a  lumber  company 
in  the  year  191 4  of  which  76  per  cent,  was  derived 
from  conversion  into  money  of  property  owned  by  the 
corporation  prior  to  March  1,  1913.  In  short,  the  divi- 
dend was  an  extraordinary  one  based  in  very  large 
part  upon  an  accumulated  surplus  represented  in  great 
measure  by  an  appreciation  in  value  of  the  company's 
timber  lands.  The  Court  held,  however,  that  as  the 
dividends  were  received  in  1914  they  were  taxable  as 
income  under  the  Federal  Income  Tax  Act,  even 
though  "they  were  extraordinary  in  amount  and  might 
appear  upon  analysis  to  be  a  mere  realization  in  pos- 
session of  an  inchoate  and  contingent  interest  that  the 
stockholder  had  in  a  surplus  of  corporate  assets  pre- 
viously existing".    The  Court  thus  denned  its  position: 

"Dividends  are  the  appropriate  fruit  of 
stock  ownership,  are  commonly  reckoned  as  in- 
come, and  are  expended  as  such  by  the  stock- 
holder without  regard  to  whether  they  are  de- 
clared from  the  most  recent  earnings,  or  from  a 
surplus  accumulated  from  the  earnings  of  the 
past,  or  are  based  upon  the  increased  value  of 
the  property  of  the  corporation.  The  stock- 
holder is,  in  the  ordinary  case,  a  different  entity 
from  the  corporation,  and  Congress  was  at  lib- 
erty to  treat  the  dividends  as  coming  to  him  ab 
extra,  and  as  constituting  a  part  of  his  income 
when  they  came  to  hand"  (id.,  p.  344). 

It  is  thus  clearly  apparent  that  had  the  shares  con- 
stituting the  'stock  dividend'  in  the  Towne  case  been 


14 

considered  to  be  income,  the  fact  that  they  represented 
a  surplus  accumulated  before  March  I,  191 3,  would  not 
have  precluded  the  imposition  of  the  tax,  as  that  fact 
did  not  preclude  the  imposition  of  the  tax  upon  the 
distribution  of  the  surplus  so  accumulated  by  the  cor- 
poration in  Lynch  v.  Hornby.  The  distinction  was  not 
in  the  time  when  the  surplus  had  been  accumulated  but 
in  the  fact  that  in  Lynch  v.  Hornby  there  was  actually 
appropriated  to  the  stockholder  through  the  dividend 
a  certain  amount  of  property,  which  became  the  stock- 
holder's individual  property  and  was  no  longer  a  con- 
tingent interest  in  corporate  assets,  while  in  the  Towne 
case  there  was  a  mere  capitalization  of  surplus  which 
"took  nothing  from  the  property  of  the  corporation  and 
added  nothing  to  the  interest  of  the  shareholder". 

This  was  distinctly  stated  in  Peabody  v.  Bisner, 
247  U.  S.  347.  In  that  case,  the  Union  Pacific  Railroad 
Company  declared  an  extra  dividend  in  the  year  19 14 
consisting  in  part  of  certain  shares  of  stock  of  the 
Baltimore  &  Ohio  Railroad  Company,  these  shares  hav- 
ing been  owned  by  the  Union  Pacific  Railroad  Com- 
pany prior  to  March  1,  191 3.  The  Court  held  that 
although  the  dividend  was  an  extraordinary  one  and  a 
distribution  in  specie  of  a  portion  of  the  corporate 
assets,  still  it  was  to  be  considered  income  and  taxable 
as  such.  The  Court  expressly  referred  to  the  case  of 
Towne  v.  Bisner,  and  explicitly  stated  the  ground  upon 
which  the  former  decision  rested,  that  is,  that  it  was  a 
'stock  dividend'  and  not,  in  its  nature,  income.  The 
Court,  after  referring  to  the  ruling  in  the  District 
Court  in  the  Towne  case,  said: 

"The  latter  case"  (that  is,  the  Towne  case) 
"has  since  been  reversed  (245  U.  S.  418),  but 


15 

only  upon  the  ground  that  it  related  to  a  stock 
dividend  which  in  fact  took  nothing  from  the 
property  of  the  corporation  and  added  noth- 
ing to  the  interest  of  the  shareholder,  but 
merely  changed  the  evidence  which  repre- 
sented that  interest.  ...  In  this  case" 
(that  is,  the  Peabody  case)  "the  plaintiff  in 
error  stands  in  the  position  of  the  ordinary 
stockholder,  whose  interest  in  the  accumulated 
earnings  and  surplus  of  the  company  are  not 
the  same  before  as  after  the  declaration  of  a 
dividend;  his  right  being  merely  to  have  the 
assets  devoted  to  the  proper  business  of  the 
corporation  and  to  receive  from  the  current 
earnings  or  accumulated  surplus  such  dividends 
as  the  directors  in  their  discretion  may  declare ; 
and  without  right  or  power  on  his  part  to  con- 
trol that  discretion. 

"It  hardly  is  necessary  to  say  that  this  case 
is  not  ruled  by  our  decision  in  Towne  v.  Eisner, 
since  the  dividend  of  Baltimore  &  Ohio  shares 
was  not  a  stock  dividend  but  a  distribution  in 
specie  of  a  portion  of  the  assets  of  the  Union 
Pacific,  and  is  to  be  governed  for  all  present 
purposes  by  the  same  rule  applicable  to  the  dis- 
tribution of  a  like  value  of  money.  It  is  con- 
trolled by  Lynch  v.  Hornby,  this  day  decided, 
ante,  339."     (Italics  ours.) 

The  very  latest  decision  of  the  Supreme  Court  on 
this  subject  (December  9,  1918)  shows  the  Court's 
firm  adherence  to  the  view  that  where  the  transaction 
under  consideration  makes  the  tax  payer  "no  richer 
than  before"  the  Court  will  hold  the  new  evidence  of 
property  principal  and  not  income. 

Gulf  Oil  Corporation  v.  Lewellyn,  Collector, 
39  Supreme  Court  Rep.  35. 


16 


POINT  III. 

THERE  IS  NO  BASIS  FOR  THE  CONCLUSION  THAT  THE 
WORD  'INCOME'  IN  THE  SIXTEENTH  AMENDMENT 
HAS  A  BROADER  MEANING  THAN  THE  WORD  'IN- 
COME' IN  THE  INCOME  TAX  ACT  OF  1913  UNDER 
WHICH   THE  QUESTION  AROSE  IN  THE  TOWNE  CASE. 

The  Income  Tax  Act  of  October  3,  191 3  (38  Stat. 
114)  under  which  the  case  of  Tozvne  v.  Bisner  arose, 
provided  as  follows : 

"A.  Subdivision  1.  That  there  shall  be 
levied,  assessed,  collected  and  paid  annually 
upon  the  entire  net  income  arising  or  accruing 
from  all  sources  in  the  preceding  calendar  year 
to  every  citizen  of  the  United  States,  whether 
residing  at  home  or  abroad,  and  to  every  person 
residing  in  the  United  States,  though  not  a  citi- 
zen thereof,  a  tax  of  1  per  centum  per  annum 
upon  such  income,  except  as  hereinafter  pro- 
vided; and  a  like  tax  shall  be  assessed,  levied, 
collected,  and  paid  annually  upon  the  entire  net 
income  from  all  property  owned  and  of  every 
business,  trade,  or  profession  carried  on  in  the 
United  States  by  persons  residing  elsewhere. 

"Subdivision  2  (providing  for  the  surtax). 

"Every  person  subject  to  this  additional  tax 
shall,  for  the  purpose  of  its  assessment  and  col- 
lection, make  a  personal  return  of  his  total  net 
income  from  all  sources,  corporate  or  otherwise, 
for  the  preceding  calendar  year. 

"B.  That,  subject  only  to  such  exemption 
and  deductions  as  are  hereinafter  allowed,  the 
net  income  of  a  taxable  person  shall  include 


17 

gains,  profits,  and  income  derived  from  salaries, 
wages,  or  compensation  for  personal  service  of 
whatever  kind  and  in  whatever  form  paid,  or 
from  professions,  vocations,  businesses,  trade, 
commerce,  or  sales,  or  dealings  in  property, 
whether  real  or  personal,  growing  out  of  the 
ownership  or  use  of  or  interest  in  real  or  per- 
sonal property,  also  from  interest,  rent,  divi- 
dends, securities,  or  the  transaction  of  any  law- 
ful business  carried  on  for  gain  or  profit,  or 
gains  or  profits  and  income  derived  from  any 
source  whatever,  including  the  income  from  but 
not  the  value  of  property  acquired  by  gift,  be- 
quest, devise,  or  descent:     .     .     . 

"That  in  computing  net  income  for  the  pur- 
pose of  the  normal  tax  there  shall  be  allowed  as 
deductions:  .  .  .  seventh,  the  amount  re- 
ceived as  dividends  upon  the  stock  or  from  the 
net  earnings  of  any  corporation,  joint  stock 
company,  association,  or  insurance  company 
which  is  taxable  upon  its  net  income  as  herein- 
after provided     .     .     . 

"D.  .  .  .  Provided  further,  That 
persons  liable  for  the  normal  income  tax  only, 
on  their  own  account  or  in  behalf  of  another, 
shall  not  be  required  to  make  return  of  the  in- 
come derived  from  dividends  on  the  capital  stock 
or  from  the  net  earnings  of  corporations,  joint- 
stock  companies  or  associations,  and  insurance 
companies  taxable  upon  their  net  income  as 
hereinafter  provided." 

It  is  perfectly  clear  that  had  the  stock  dividend  in 
the  Towne  case  been  considered  to  be  'income'  in  its 
nature,  it  would  have  been  subject  to  the  surtax  under 


18 

these  provisions  of  the  Act  of  191 3.  The  Act  reached 
"the  entire  net  income"  arising  "from  all  sources".  It 
embraced  all  "dividends"  without  qualification  and 
"gains  or  profits  and  income  derived  from  any  source 
whatever".  There  is  not  the  slightest  ground  for  the 
exclusion  from  these  broad  descriptive  phrases  of  any- 
thing which  was  in  its  nature  'income' ,  which  had 
accrued  during  the  tax  period  and  which  was  not 
excepted  by  the  terms  of  the  Act.  It  was  in  this  view 
that  the  Supreme  Court  held  in  Lynch  v.  Hornby  that 
the  Act  reached  extraordinary  dividends  from  surplus 
which  had  been  accumulated  before  March  1,  191 3, 
even  where  the  surplus  embraced  the  increased  value 
of  the  property  of  the  corporation.  While  the  distri- 
bution was  an  extraordinary  one,  it  was  held  to  be 
within  the  comprehensive  words  of  the  Act  covering 
income  from  all  sources.  The  Supreme  Court  expressly 
overruled  the  contention  that  the  words  of  the  Act  of 
19 1 3  could  be  read  in  connection  with  the  explicit  pro- 
vision of  the  later  Income  Tax  Act  of  191 6  so  as  to 
exclude  dividends  declared  out  of  earnings  or  profits 
which  had  accrued  prior  to  March  1,  191 3.  The  later 
Act  of  19 16  expressly  excluded  dividends  out  of  earn- 
ings or  profits  which  had  accrued  before  March  1,  191 3 
{ante,  p.  4),  but  the  Supreme  Court  held  that  no  such 
qualification  could  be  read  into  the  broad  words  of  the 
Act  of  191 3  {Lynch  v.  Hornby,  247  U.  S.  344-345). 
The  only  ground  for  holding  the  'stock  dividend'  in  the 
Towne  case  not  to  be  taxable,  although  the  shares  were 
issued  in  the  year  191 4  under  a  corporate  resolution  of 
December,  191 3,  was  that  the  'stock  dividend'  was  not 
income  in  its  nature.    And  this  being  so,  it  necessarily 


19 

follows  that  it  was  just  as  much  excluded  from  the 
authority  conferred  by  the  Sixteenth  Amendment  as  it 
was  from  the  provision  of  the  Act  of  191 3.  If  Con- 
gress had  the  power  to  tax  the  'stock  dividend',  because 
the  'stock  dividend'  was  income,  there  is  no  escape  from 
the  conclusion  that  it  did  tax  it  in  the  Act  of  191 3.  And, 
if  the  'stock  dividend'  in  the  Towne  case  was  not  within 
that  Act,  it  was  only  by  virtue  of  the  fact  that  it  was 
not  income  in  any  sense  for  the  purpose  of  taxation  as 
such. 

It  in  no  way  militates  against  this  view  that  a  given 
word  may  not  have  the  same  meaning  as  used  in  dif- 
ferent statutes  or  in  the  Constitution  and  a  statute.  As 
Mr.  Justice  Holmes  said  in  the  Towne  case,  "A  word 
is  not  a  crystal,  transparent  and  unchanged,  it  is  the 
skin  of  a  living  thought  and  may  vary  greatly  in  color 
and  content  according  to  the  circumstances  and  the 
time  in  which  it  is  used".  This  was  said  in  the  Towne 
case  in  denying  the  motion  to  dismiss  the  writ  of  error. 
The  Government  urged  that  there  was  nothing  before 
the  Court  but  the  construction  of  a  statute  and  hence 
that  there  was  no  propriety  in  a  direct  writ  of  error. 
In  short,  the  motion  to  dismiss  was  upon  the  ground 
that,  as  the  same  word  was  used  in  both  Constitution 
and  statute,  no  constitutional  question  could  be  in- 
volved. The  plaintiff  in  error,  however,  had  contended 
that  if  the  Act  of  Congress  was  construed  to  authorize 
a  tax  upon  the  'stock  dividend'  in  question,  the  Act  was 
unconstitutional.  As  Mr.  Justice  Holmes  said,  the 
Government  had  applied  the  force  of  the  Constitution  to 
the  plaintiff  upon  the  assertion  that  the  statute  had  au- 
thorized it  to  do  so,  and,  of  course,  the  plaintiff  in  error 


20 

was  entitled  to  take  his  appeal  to  the  Supreme  Court, 
urging  that  the  Act  was  invalid  if  it  had  the  meaning 
for  which  the  Government  had  contended  and  which 
the  Court  below  had  assigned  to  it. 

The  point  of  the  decision  in  this  aspect  was  that 
the  fact  that  the  same  word  as  used  in  both  Consti- 
tution and  statute  did  not  eliminate  the  constitutional 
question.  The  party  insisting  that  he  was  taxed  uncon- 
stitutionally through  the  application  of  the  statute,  still 
had  his  right  to  go  to  the  tribunal  which,  according  to 
the  distribution  of  appellate  jurisdiction,  was  to  de- 
termine constitutional  questions.  But  the  Supreme 
Court  having  jurisdiction  of  the  writ  of  error  what- 
ever it  might  think  of  the  question  whether  the  'stock 
dividend'  was  or  was  not  income,  then  proceeded  to 
determine  the  case,  not  upon  the  theory  of  a  limited  use 
of  the  word  'income'  in  the  statute,  but  with  regard 
to  the  essential  characteristics  of  the  'stock  dividend', 
holding  that  it  was  not  income  in  its  nature. 

The  character  of  this  determination  is  not  to  be 
obscured  by  the  ruling  on  the  question  of  jurisdiction. 
Because  the  same  word  may  be  used  in  different  senses 
in  the  Constitution  and  a  statute,  and  thus  a  constitu- 
tional question  as  well  as  a  question  of  statutory  con- 
struction may  be  involved,  it  does  not  follow  that  the 
reasoning  of  the  decision  on  the  merits  may  not  be  so 
fundamental  and  controlling  with  respect  to  the  mean- 
ing of  the  word  as  to  determine  the  question  of  consti- 
tutional interpretation.  The  Supreme  Court  had  jur- 
isdiction to  determine  the  meaning  of  the  word  'in- 
come' both  as  used  in  the  statute  and  as  used  in  the 
Constitution,  but  in  determining  that  the  'stock  divi- 


21 


dend'  did  not  fall  within  the  description  of  income,  it 
based  its  conclusion  upon  reasoning  which  had  no  ref- 
erence to  the  special  time  or  circumstance  of  the  statute 
but  to  the  nature  of  the  property  itself,  and  its  con- 
clusion that  the  'stock  dividend'  was  not  income  was 
thus  based  upon  a  ground  applicable  both  to  the  Consti- 
tution and  to  the  statute.  In  fact  the  statute  was 
enacted  immediately  after  the  Sixteenth  Amendment 
was  adopted  and  manifestly  with  the  same  intent. 

The  truth  is  that  the  possible  distinction,  presented 
in  the  Towne  case,  between  the  meaning  of  the  word 
'income'  as  used  in  the  Constitution,  and  its  meaning 
as  used  in  the  statute,  lay  in  the  circumstance  that  the 
'stock  dividend'  there  was  based  upon  a  surplus  accumu- 
lated before  the  Sixteenth  Amendment  was  adopted, 
that  is,  before  March  i,  191 3.  If  the  Court  had  con- 
sidered 'stock  dividends'  to  be  income  in  their  nature, 
and  thus  within  the  purview  of  the  Sixteenth  Amend- 
ment, the  Court  might  then  have  said  that,  while  this 
was  true,  the  statute  did  not  intend  to  embrace  divi- 
dends derived  from  corporate  accumulations  which 
had  accrued  before  the  effective  date  of  the  Act.  But 
the  Court  was  of  the  contrary  view.  The  Court  was  of 
the  opinion,  as  shown  by  its  later  decisions  in  Lynch  v. 
Hornby  and  Peabody  v.  Eisner,  that  the  Act  of  191 3 
did  reach  dividends  subsequently  declared,  although 
derived  from  corporate  accumulations  antedating 
March  1,  1913.  It  was  of  the  view  that  the  Act  of 
191 3  reached  dividends  thus  derived,  even  though  they 
were  extraordinary  or  distributed  corporate  assets  in 
specie. 

The  possible  distinction  with  respect  to  the  scope 


of  the  statute  was  thus  eliminated  and  the  Court  hence 
came  to  deal  with  the  essential  quality  of  'stock  divi- 
dends' and  with  the  fundamental  and  controlling  ques- 
tions whether  they  were  in  their  nature  'income'.  We 
cannot  doubt,  said  the  Court,  "that  the  dividend  was 
capital".  And  thus,  holding  that  it  was  'capital'  and 
not  'income',  upon  the  consideration,  not  of  time,  cir- 
cumstance or  limitation  peculiarly  relating  to  the  stat- 
ute, but  of  the  nature  of  the  so-called  'stock  dividend', 
that  is,  of  the  shares  issued,  the  reasoning  of  the  Court 
excluded  the  'stock  dividend',  not  simply  from  the  opera- 
tion of  the  statute,  but  from  that  of  the  constitutional 
Amendment  itself. 

For  the  purpose  of  reaching  property  of  this  sort, 
whose  nature  has  thus  been  determined  authoritatively, 
the  word  'income'  in  the  Amendment  cannot  be 
deemed  to  be  any  more  effective  than  the  word  'in- 
come' as  used  in  the  Act  of  1913. 


POINT  IV. 

'STOCK  DIVIDENDS'    ARE    NOT    INCOME    WITHIN    THE 
MEANING  OF  THE  SIXTEENTH  AMENDMENT. 

A  'stock  dividend'  is  not  income  to  the  stockholder 
receiving  it,  but  is  a  mere  readjustment  of  the  evi- 
dence of  the  stockholder's  interest  already  owned. 
The  'stock  dividend'  takes  nothing  from  the  property 
of  the  corporation  and  adds  nothing  to  the  interests 
of  the  stockholders.  The  only  change  in  substance  is 
that,  instead  of  the  property  represented  thereby  being 


23 


distributed  to  stockholders,  it  is  permanently  fixed  as 
capital  so  that  it  cannot  be  distributed. 

The  situation  here  presented  is  a  typical  one  and 
the  facts  to  which  the  question  is  addressed  are 
familiar. 

A  corporation  is  not  bound  to  distribute  all  its 
earnings  in  dividends.  The  directors  may  properly 
decide  to  use  a  portion  of  the  earnings  for  the  develop- 
ment of  business,  for  the  extension  of  plant,  for  bet- 
terments and  for  working  capital.  The  undivided 
surplus  of  a  corporation  is  not,  normally,  idle  money; 
it  is,  normally,  invested  money.  It  is  money  invested 
in  property,  or  embarked  in  the  corporate  enterprise; 
that  is  the  reason  it  is  not  paid  out  in  dividends.  If 
the  directors  have  not  transcended  the  broad  limits  of 
their  judgment,  the  stockholders  cannot  complain  be- 
cause earnings  are  invested  instead  of  being  dis- 
tributed. 

The  interest  of  the  stockholders,  with  respect  to 
the  property  of  the  corporation,  is  an  interest  in  the. 
aggregate  assets  of  the  company,  subject  to  the  pay- 
ment of  debts.  It  is  not  an  interest  in  the  segregated 
portion  representing  the  original  subscriptions;  it  is 
not  an  interest  limited  to  an  amount  equal  to  the  par 
value  of  their  shares;  it  is  not  an  interest  limited  to 
any  particular  portion  of  the  corporate  property,  in 
the  absence  of  special  charter  provisions,  but  is  simply 
an  interest  in  all  the  corporate  assets.  When  these 
assets  are  swelled  by  the  addition  of  undivided  profits, 
the  interest  of  the  stockholders  in  these  accumulations 
is  precisely  the  same  as  their  interest  in  any  other 
property  of  the  corporation.     "The  property  of  every 


24 


company  may  consist  of  three  separate  distinct  things, 
which  are  its  capital  stock,  its  surplus,  its  franchise. 
But  these  three  things,  several  in  the  ownership  of  the 
company,  are  united  in  the  ownership  of  the  share- 
holders. The  share  stock  covers,  embraces,  repre- 
sents all  three  in  their  totality,  for  it  is  a  business 
photograph  of  all  the  corporate  possessions  and  possi- 
bilities." {People  ex  rel.  W.  U.  T.  Co.  v.  Coleman,  126 
N.  Y.  433,  438.) 

When  dividends  are  declared  the  amounts  of  the 
dividends  are  separated  from  the  corporate  property 
and  are  received  by  the  stockholders  respectively  as 
their  separate  property.  But  until  dividends  separat- 
ing money  or  property  from  the  corporate  assets  in 
this  way  are  declared,  the  stockholders  continue  to  re- 
tain the  interest  in  all  these  assets  represented  by  their 
stock,  the  extent  and  value  of  their  aggregate  interests 
depending  not  upon  the  sums  originally  contributed  to 
capital,  but  upon  the  extent  and  value  of  all  the  assets 
of  the  corporation,  including  its  accumulations,  after 
deducting  liabilities.  When  a  so-called  'stock  divi- 
dend' is  declared,  the  company  does  not  distribute  but 
continues  to  hold  the  property  upon  which  the  stock 
issue  rests.  Its  undivided  profits  previously  invested 
in  the  enterprise  continue  to  be  so  invested.  Instead 
of  being  a  "dividend"  in  any  proper  sense,  the  effect 
of  the  action  is  that  there  shall  be  no  dividends  of  the 
accumulations  capitalized.  The  aggregate  interests 
of  the  stockholders  remain  unchanged  and  their  pro- 
portional interests  remain  unchanged. 

Thus,  a  'stock  dividend',  or  increase  of  capital  stock 


25 

against     surplus     accumulations,     accomplishes     two 
things : 

( i )  The  amount  represented  by  the  'stock  divi- 
dend' is  permanently  classified  so  that  it  cannot  be  paid 
out  as  dividends. 

(2)  The  number  of  shares  is  increased  without 
affecting  the  title  of  the  corporation  to  any  part  of  the 
corporate  property  and  without  adding  to  the  ratable 
interests  of  the  stockholders. 

Upon  a  liquidation  immediately  before  the  'stock 
dividend '  the  stockholder  would  have  received  pre- 
cisely the  same  amount  as  he  would  have  received  upon 
a  liquidation  immediately  after  the  'stock  dividend'. 
So  far  as  the  paper,  or  stock  certificate,  issue  is  con- 
cerned, it  is  an  evidence  of  an  interest  already  owned 
and  permanently  capitalized. 

These  plain  incidents  of  the  transaction  have  been 
repeatedly  and  authoritatively  described. 

"The  corporate  property  remains  the  same 
after  the  stock  is  increased  as  before  and  the 
interest  of  each  stockholder  in  the  corporate 
property  is  also  unchanged." 

Kaufman   v.    Charlottesville    Woolen   Mills 
Co.,  93  Va.  673,  675. 

"After  a  stock  dividend  a  corporation  has 
just  as  much  property  as  it  had  before  .  .  .  after 
such  a  dividend  the  aggregate  of  the  stockhold- 
ers own  no  more  interest  in  the  corporation  than 
before.  The  whole  number  of  shares  before 
the  stock  dividend  represented  the  whole  prop- 
erty of  the  corporation,  and  after  the  dividend 


they  represent  that  and  no  more.  A  stock  divi- 
dend does  not  distribute  property,  but  simply 
dilutes  the  shares  as  they  existed  before." 

Williams  v.  Western  Union  Telegraph  Co., 
93  N.  Y.  162,  189. 

"There  is  a  clear  distinction  between  the  or- 
dinary cash  dividend,  no  matter  when  earned, 
and  a  stock  dividend  declared  as  in  the  case  at 
bar.  The  one  is  a  disbursement  to  the  stock- 
holder of  accumulated  earnings,  and  the  cor- 
poration at  once  parts  irrevocably  with  all  in- 
terest therein.  The  other  involves  no  disburse- 
ment by  the  corporation.  It  parts  with  nothing 
to  the  stockholder.  The  latter  represents  not 
an  actual  dividend,  but  certificates  of  stock 
which  evidence  in  a  new  proportion  his  interest 
in  the  entire  capital,  including  such  as  by  invest- 
ment of  accumulated  profits  has  been  added  to 
the  original  capital." 

DeKovenv.  Alsop,  205  111.  309. 

"It  is  the  characteristic  feature  of  a  stock 
dividend  that  the  property  of  the  corporation 
itself  remains  unchanged,  but  that  each  one  of 
the  shares  of  the  increased  stock  represents  a 
smaller  fractional  interest  than  before  in  the 
total  amount  of  the  corporate  property.  On  the 
other  hand,  it  is  the  characteristic  feature  of  a 
dividend  declared  and  paid  wholly  from  the  net 
profits  or  undivided  earnings  that  it  does  dimin- 
ish the  property  of  the  corporation  by  exactly 
the  amount  of  the  dividend  so  paid  out,  while 
it  leaves  the  fractional  interest  represented  by 
each  share  of  the  capital  stock  exactly  where  it 
was  before.  Gibbons  v.  Mahon,  136  U.  S.  549, 
559,  56o." 
Gray  v.  Hemenway,  212  Mass.  239. 


27 


"The  word  'dividends'  if  unqualified,  sig- 
nifies dividends  payable  in  money.  The  word 
'income'  has  a  broader  meaning,  but  hardly 
broad  enough  to  include  things  not  separated 
in  some  way  from  the  principal.  It  is  not 
synonymous  with  'increases'.  The  value  of 
stock  may  be  increased  by  good  management, 
prospects  of  business,  and  the  like.  But  such 
increase  is  not  income.  It  may  also  be  increased 
by  the  accumulation  of  surplus;  but  so  long  as 
that  surplus  is  retained  by  the  corporation 
either  as  surplus  or  as  increased  stock,  it  can  in 
no  proper  sense  be  called  income." 
Spooner  v.  Phillips,  62  Conn.  62,  68. 

"It  is  also  one  of  the  incidents  of  a  stock  div- 
idend that  the  shareholder  who  receives  his  pro 
rata  proportion  of  the  new  issue,  while  he  ac- 
quires the  ownership  of  more  shares,  adds  noth- 
ing to  his  proportionate  ownership  of  the  assets 
of  the  corporation.  His  holding,  after  the  new 
issue,  bears  precisely  the  same  ratio  to  the  total 
of  the  outstanding  shares  as  did  his  previous 
holding  to  the  previous  total  {Terry  v.  The 
Bagle  Lock  Co.,  47  Conn.  141,  165).  The  un- 
derlying idea  of  a  cash  dividend,  on  the  other 
hand,  is  the  distribution  to  shareholders  as  the 
rewards  of  the  corporate  enterprise  of  a  portion 
of  the  profits  or  surplus  assets  of  the  corpora- 
tion. .  .  .  Whatever  form  the  distribution 
takes,  the  result  always  is  the  reduction  of  both 
the  corporate  assets  and  surplus  by  just  the 
amount  of  the  distribution.  Something  is  taken 
from  the  corporation  and  given  to  the  stockhold- 
ers.    All  which  is  distributed  becomes  released 


28 

from  all  corporate  control  and  goes  under  the 
dominion  of  the  share  owners." 

Green  v.  Bissell,  79  Conn.  547,  551. 
See  also, 

Terry  v.  Eagle  Lock  Co.,  47  Conn.  141. 

Brinley  v.  Grou,  50  Conn.  66. 

Bonch  v.  Sproule,  12  App.  Cas.  385. 

Jones  v.  Evans  (1913),  1  Ch.  23. 

In  re  Carson,  Irish  Reports  (1915),  Vol.  I, 
p.  321. 

Guinness,  Trustee,  v.  Guinness,  Cases  Ct.  of 
Session,  5th  Series,  Vol.  6,  p.  104. 

Minot  v.  Paine,  99  Mass.  101. 

Davis  v.  Jackson,  152  Mass.  58. 

D'Ooge  v.  Leeds,  176  Mass.  558. 

Hyde  v.  Holmes,  198  Mass.  287. 

Brown  v.  Lamed,  14  R.  I.  371,  373. 

Billings  v.  Warren,  216  111.  281. 

Lancaster  v.  Mason,  152  No.  Car.  660. 

GWotf  Western  Mining  &  Mfg.  Co.  v.  Harris, 
128  Fed.  321,  326. 

A  genuine  dividend  constitutes  a  debt  between  the 
corporation  and  the  shareholders;1*  once  declared  it 
may  not  be  rescinded  2*  and  an  action  may  be  brought 
on  the  debt.1* 

It  is  otherwise  with  a  stock  issue  made  to  share- 
holders (commonly  called  a  'stock  dividend'),  for,  as 
the  directors  do  not  divide  anything  and  in  substance 

r*King  v.  Paterson,  29  N.  J.  L.  504;  Hunt  v.  O'Shea,  69  N.  H.  600; 
Lockhart  v.  Van  Alstyne,  31  Mich.  76;  Stoddard  v.  The  Shetucket 
Foundry  Co.,  34  Conn.  542. 

**  Wheeler  Beers  &  Others  v.  The  Bridgeport  Spring  Co.,  42  Conn. 
17;  Stoats  v.  Bio  graph  Co.,  236  Fed.  454. 


29 


merely  readjust  the  symbols  by  which  the  shareholders 
own  the  net  assets,  they  may  recall  their  own  action 
and  leave  the  shareholders  without  grievance. 

In  Staats  v.  Biograph  Co.,  236  Fed.  454,  the  Cir- 
cuit Court  of  Appeals  for  the  Second  Circuit,  holding 
that  the  action  of  a  board  of  directors  in  declaring  a 
'stock  dividend'  might  be  rescinded,  said  (p.  457)  : 

"In  this  case  it  does  not  escape  observation 
that  the  plaintiff's  right  to  a  stock  dividend,  if 
he  has  such  a  right  and  can  enforce  it,  would 
gain  him  nothing.  We  say  it  would  gain  him 
nothing,  because  while  a  stock  dividend  would 
increase  the  number  of  his  shares,  it  propor- 
tionately diminishes  the  value  of  each  of  his 
shares,  leaving  the  aggregate  value  as  it  was 
before.  He  acquires  the  ownership  of  more 
shares  but  he  adds  nothing  to  his  proportionate 
ownership  of  the  assets  of  the  corporation." 

The  question  of  the  nature  of  a  'stock  dividend' 
was  considered  by  the  Supreme  Court  in  the  leading 
case  of  Gibbons  v.  Mahon,  136  U.  S.  549,  where  it  was 
decided  that  it  is  in  its  nature  capital  and  not  income. 

That  was  a  case  of  a  will  bequeathing  stock  in  a 
corporation  and  government  bonds  in  trust  to  pay  "the 
dividends  on  said  stock  and  the  interest  on  said  bonds 
as  they  accrue"  to  a  daughter  of  the  testator,  and  di- 
recting that  upon  her  death  "the  said  stock,  bonds, 
and  income  shall  revert  to  the  estate  of  the  trustee." 
The  corporation  accumulated  earnings  from  time  to 
time,  before  and  after  the  death  of  the  testator,  which 
were  invested  in  its  permanent  works  and  plant.  It 
declared  a  'stock  dividend'  representing  these  accumu- 


lated  earnings  and  the  question  was  whether  this 
'stock  dividend'  was  income.  It  was  held  to  be  capital 
and  that  it  should  go  to  the  remainderman,  only  the 
dividends  which  might  be  received  on  such  stock  being 
payable  to  the  tenant  for  life. 

After  reviewing  the  authorities  of  other  jurisdic- 
tions, Mr.  Justice  Gray  discussed  the  nature  of  a 
'stock  dividend'; 

"Money  earned  by  a  corporation  remains 
the  property  of  the  corporation,  and  does  not 
become  the  property  of  the  stockholder,  unless 
and  until  it  is  distributed  among  them  by  the 
corporation.  The  corporation  may  treat  it 
and  deal  with  it  either  as  profits  of  its  business, 
or  as  an  addition  to  its  capital.  Acting  in  good 
faith  and  for  the  best  interests  of  all  con- 
cerned, the  corporation  may  distribute  its  earn- 
ings at  once  to  the  stockholders  as  income;  or 
it  may  reserve  part  of  the  earnings  of  a  pros- 
perous year  to  make  up  for  a  possible  lack  of 
profits  in  future  years;  or  it  may  retain  por- 
tions of  its  earnings  and  allow  them  to  accumu- 
late, and  then  invest  them  in  its  own  works  and 
plant,  so  as  to  secure  and  increase  the  perma- 
nent value  of  its  property"  (p.  588). 

"When  a  distribution  of  earnings  is  made 
by  a  corporation  among  its  stockholders,  the 
question  whether  such  distribution  is  an  ap- 
portionment of  additional  stock  representing 
capital,  or  a  division  of  profits  and  income,  de- 
pends upon  the  substance  and  intent  of  the 
action  of  the  corporation,  as  manifested  by 
its  vote  or  resolution ;  and  ordinarily  a  dividend 
declared  in  stock  is  to  be  deemed  capital,  and 


31 


a  dividend  in  money  is  to  be  deemed  income,  of 
each  share." 

"A  stock  dividend  really  takes  nothing  from  the 
property  of  the  corporation,  and  adds  nothing  to  the 
interests  of  the  shareholders.  Its  property  is  not 
diminished,  and  their  interests  are  not  increased. 
After  such  a  dividend,  as  before,  the  corporation  has 
the  title  in  all  the  corporate  property;  the  aggregate 
interests  therein,  of  all  the  shareholders  are  repre- 
sented by  the  whole  number  of  shares;  and  the  pro- 
portional interest  of  each  shareholder  remains  the 
same.  The  only  change  is  in  the  evidence  which  rep- 
resents that  interest,  the  new  shares  and  the  original 
shares  together  representing  the  same  proportional 
interest  that  the  original  shares  represented  before 
the  issue  of  new  ones"  (pp.  559-60). 

"The  resolution  is  clearly  an  apportionment 
of  the  new  shares  as  representing  capital,  and 
not  a  distribution  or  division  of  income.  As 
well  observed  by  Mr.  Justice  James,  delivering 
the  opinion  of  the  Court  below:  'Certificates 
of  stock  are  simply  the  representative  of  the 
interest  which  the  stockholder  has  in  the  capi- 
tal of  the  corporation.  Before  the  issue  of 
these  two  hundred  and  eighty  new  shares,  this 
trustee  held  precisely  the  same  interest  in  this 
increased  plant  in  the  capital  of  the  corporation 
that  she  held  afterwards.  She  merely  had  a 
new  representative  of  an  interest  that  she 
already  owned,  and  which  was  not  increased 
by  the  issue  of  the  new  shares.  A  dividend  is 
something  with  which  the  corporation  parts, 
but  it  parted  with  nothing  in  issuing  this  new 
stock.     It  simply  gave  a  new  evidence  of  own- 


ership  which  already  existed.  They  were  not 
in  any  sense,  therefore,  dividends  for  which 
this  trustee  had  to  account  to  the  cestui  que 
trust.  She  stood  after  the  issue  of  the  new 
shares  just  as  she  had  stood  before;  and  the 
trustee  was  obliged  to  treat  them  just  as  she 
did,  namely,  as  a  part  of  the  original,  and  to 
pay  the  dividends  to  the  cestui  que  trust'  " 
(P.  5°9)- 

Gibbons  v.  Mahon  was  long  held  under  advisement 
by  the  Court,  and  it  is  apparent  that  it  was  decided 
after  the  most  thorough  consideration.  We  have 
quoted  at  length  from  the  opinion,  because  the  ratio 
decidendi  renders  unavailing  the  efforts  which  have 
been  made  to  distinguish  this  case.  The  Court  ex- 
plicitly rests  its  decision  upon  the  essential  nature  of 
the  transaction — that  is,  upon  a  consideration  of  the 
essential  quality  of  a  'stock  dividend'  based  there,  as 
here,  on  accumulated  surplus  invested  in  plant  and 
property  and  by  appropriate  resolution  permanently 
classified  as  capital.  The  opinion  makes  it  clear  that 
it  was  not  a  rule  particularly  applicable  to  wills,  or 
trusts,  but  the  nature  and  effect  of  the  corporate  action 
which  determined  the  conclusion  of  the  Court.  If  the 
'stock  dividend'  was  not  receivable  as  income,  when  if 
income  the  claimant  would  have  been  entitled  to  receive 
it,  it  could  hardly  be  said  that  it  should  be  taxed  as 
income.  Had  it  been  income,  the  cestui  que  trust 
would  have  succeeded,  but  because  the  Court  consid- 
ered it  not  to  be  income  she  lost  her  suit.  If  the  'stock 
dividend'  was  not  income  for  the  purpose  of  distribu- 
tion to  the  beneficiary  of  the  income,  we  cannot  con- 


ceive  that  it  could  have  been  regarded,  had  an  income 
tax  law  been  in  operation,  as  income  for  the  purpose 
of  taxing  it. 

Gibbons  v.  Mahon  was  an  exposition  by  which  the 
final  authority  defined  to  this  extent,  by  exclusion,  the 
meaning  of  "income".  The  usual  rule  is  that  when  a 
word  which  has  received  judicial  construction  is  sub- 
sequently used  in  Federal  legislation  it  should  be  pre- 
sumed to  have  been  used  in  the  sense  determined  by  the 
Court  (Kepner  v.  United  States,  195  U.  S.  100,  124; 
Latimer  v.  United  States,  223  U.  S.  501,  504).  And 
this  principle,  it  is  submitted,  should  be  applied  in  the 
construction  of  the  Sixteenth  Amendment.  Authori- 
tative judicial  decision  is  our  glossary  of  terms  used  in 
statutes  and  constitutions;  and  it  was  this  exposition 
of  the  meaning  of  'income'  in  Gibbons  v.  Mahon  which 
the  court  adopted,  without  qualification,  in  Towne  v. 
Eisner,  245  U.  S.  418. 

We  are  concerned  here  with  the  property  interest 
represented  by  the  stock  in  question  upon  which  the 
plaintiff  had  been  taxed.  This  stock  represents  (1) 
the  right  to  have  the  corporate  property  managed  ac- 
cording to  the  fundamental  compact  or  contract  of 
membership;  (2)  the  right  to  receive  dividends,  when 
duly  declared,  that  is,  amounts  separated  from  the  cor- 
porate assets  and  vested  in  the  stockholders  individ- 
ually; and,  (3)  the  ratable  interest  in  the  aggregate  of 
the  corporate  assets  to  which  the  stockholders  would 
be  entitled  upon  liquidation. 

With  respect  to  management,  the  stockholder's 
rights  are  unchanged  save  to  the  extent  that  the 
accumulated  surplus,  which  is  represented  by  the  new 


34 


stock,  is  no  longer  subject  to  the  discretion  of  the 
directors  in  distribution  but  is  classified  as  capital  and 
must  be  retained  by  the  corporation  as  such. 

With  respect  to  dividends  that  may  be  declared 
upon  this  stock, — whenever  any  such  dividend  is  de- 
clared and  there  is  thus  segregated  from  the  corporate 
property  an  amount  which  the  stockholder  receives,  he 
will  be  taxable  accordingly. 

It  is  argued  that  the  effect  is  the  same  as  though 
a  cash  dividend  had  been  declared,  and  its  amount  re- 
ceived by  the  plaintiff,  and  she  had  then  invested  this 
amount  in  the  new  stock.  The  same  argument  was 
made  unavailingly  in  Tozvne  v.  Eisner.  It  is  manifest 
that  the  two  things  mentioned,  instead  of  being  the 
same,  are  different,  both  legally  and  practically.  When 
the  cash  dividend  is  declared  and  the  amount  is  re- 
ceived, the  stockholder  obtains  something  which  he 
owns  and  which  he  may  reinvest  or  not  as  he  pleases. 
He  receives  property  in  his  exclusive  ownership,  and 
he  exercises  the  freedom  of  choice.  In  the  case  of  a 
'stock  dividend',  he  obtains  nothing  but  an  evidence  of 
what  he  already  owns;  he  has  no  freedom  to  invest  or 
not  invest;  and  the  investment  is  permanently  capital- 
ized. This  distinction  was  pointed  out  in  Davis  v.  Jack- 
son, 152  Mass.  58. 

It  is  argued  further  that  the  certainty  that  these 
earnings  of  the  corporation  could  thenceforth  never  be 
distributed  as  dividends,  was  a  valuable  assurance  of 
the  continued  solvency  of  the  company  to  the  stock- 
holder, and  that  this  assurance  was  subject  to  a  tax 
as  income  of  the  individual  stockholder.  But  before 
the  'stock  dividend'  the  stockholder's  interest  in  the 


35 

corporate  assets  could  not  be  taken  away,  except 
through  mismanagement  or  losses,  and  his  interest 
continues  to  be  subject  to  these  contingencies  as  before. 
Previously,  if  there  were  distribution  in  cash,  he  would 
receive  his  dividend  and  own  the  amount.  The  propo- 
sition that  the  certainty  that  a  man  will  never  receive 
a  given  fund  is  equivalent  to  his  actual  receipt  of  that 
fund  will  appeal  less  to  the  shareholder's  sense  of  logic 
than  to  his  sense  of  humor. 

The  argument  that  a  'stock  dividend'  is  income 
fails  to  distinguish  between  the  effect  of  the  dollar 
sign  printed  on  the  certificates  of  stock  as  indicating 
the  amount  contributed  to  "capital",  and  the  interest  of 
the  stockholder  in  the  aggregate  corporate  assets,  with 
which  this  dollar  sign,  or  the  par  value  of  his  shares, 
has  nothing  to  do.  As  to  the  corporation,  its  net  assets 
are  divided  into  two  groups,  "capital"  and  "surplus", 
with  different  legal  attributes,  and  the  dividing  line 
between  the  two  groups  is  shown  by  the  nominal  or  par 
value  of  the  company's  stock,  or  the  amount  of  the  con- 
tributed "capital". 

In  the  case  at  bar,  for  example,  The  Standard  Oil 
Company  of  California  had  $49,686,656  of  capital 
stock,  and  $94,538,919.  of  assets.  The  $49,686,656  of 
capital  was  divided  into  496,866  shares  of  the  par 
value  of  $100.  each.  These  $49,686,656  represented, 
in  a  general  sense,  a  trust  fund  to  be  used  by  the  cor- 
poration in  the  conduct  of  its  business  and  for  the  pay- 
ment of  its  debts ;  none  of  it  could  lawfully  be  separated 
from  the  company  and  paid  to  its  stockholders.  The 
other  $44,852,263.  of  its  assets  represented  surplus 
which  the  company  was  free  to  dispose  of  in  any 


36 

manner  that  it  saw  fit.  There  were  496,866  shares  of 
stock  outstanding;  the  dollar  mark  on  each  certificate, 
indicating  the  par  value  of  each  share,  was  of  im- 
portance in  indicating  the  amount  of  the  contributed 
capital  stock,  and  therefore  the  dividing  line  between 
these  two  groups  of  its  net  assets. 

But  there  was  no  such  distinction  with  regard  to 
the  stockholder's  interest  in  the  aggregate  corporate 
assets.  As  to  this  the  dollar  mark  on  his  certificate 
was  immaterial.  Each  share  of  stock  represented 
1/496,866  part  of  the  net  assets  of  the  corporation, 
and  those  assets  might  amount  to  $1,000,000.  or 
$50,000,000,  and  this  was  true  whether  his  stock  had 
a  nominal  par  value  or  whether,  as  is  permitted  in  vari- 
ous States,  it  was  "no  par  value"  stock. 

When  it  is  argued  that  in  receiving  a  'stock  divi- 
dend', a  stockholder  receives  from  the  corporation 
something  of  value  which  must  therefore  be  income, 
there  is  an  inaccuracy  in  terms.  If  I  exchange  a  two- 
dollar  bill  with  the  money  changer  for  two  one-dollar 
bills,  I  have,  it  is  true,  received  from  him  something 
of  value,  but  my  property  interest  remains  entirely 
unchanged,  and  I  have  surely  not  received  any 
"income". 

If  the  Standard  Oil  Company  of  California  had 
outstanding  496,866  shares  of  capital  stock  of  the 
nominal  or  par  value  of  $100.  each,  and  had  issued  in 
exchange  therefor  993,732  shares  of  the  nominal  or 
par  value  of  $50.  each,  each  stockholder  would  have 
received  an  increased  number  of  tangible  evidences  of 
his  ownership  in  the  assets  of  the  corporation.  He 
would  have  no  greater  interest  in  the  assets  of  the  cor- 


37 

poration  than  he  had  before,  and  the  dividends  he 
might  thereafter  receive  on  his  holdings  of  $50.  shares 
would  be  just  as  large  as  if  he  received  dividends  on 
his  original  $100.  holdings.  But  the  Government 
would  not  contend  that  such  an  alteration  of  the  stock- 
holder's certificates  constituted  income. 

It  undoubtedly  will  be  conceded  by  the  Govern- 
ment that  if  a  corporation  having  a  million  dollars 
of  capital  and  with  no  surplus,  waters  its  stock  and 
issues  a  50  per  cent,  'stock  dividend'  to  its  stock- 
holders, the  new  stock,  not  representing  an  increase 
of  assets,  would  not  constitute  taxable  income  in  the 
hands  of  the  shareholder;  the  receipt  by  the  stock- 
holder of  certificates  of  stock  having  an  increased 
nominal  or  par  value  does  not  increase  the  stock- 
holder's real  interest  in  the  corporation,  and  therefore 
the  change  does  not  constitute  income. 

The  effect  of  this  concession  cannot  be  overcome. 
It  is  conceded  that  the  increase  of  the  number  of 
shares  into  which  the  assets  of  the  corporation  are 
divided,  or  the  issue  of  a  new  series  of  fractional  cer- 
tificates, does  not  constitute  income  to  the  stockholder 
if  the  corporation  has  no  accumulated  surplus,  even 
though  the  nominal  or  par  value  of  the  shares  of 
stock  owned  by  each  stockholder  is  thereby  increased. 
It  is  conceded  that  mere  increase  in  the  number  of 
shares  into  which  the  capital  of  a  corporation  is  divided 
does  not  constitute  income,  and  this  regardless  of  the 
question  whether  the  corporation  has  available  accumu- 
lated surplus  or  not.  And  it  is  just  as  true  that  the 
stockholder's  ■  interest  in  the  aggregate  corporate 
assets  remains  unchanged  when  there  is  an  increase 


38 

of  stock  based  on  accumulated  surplus.  The  change  is 
simply  that  the  amount  is  permanently  capitalized  so 
that  it  cannot  be  distributed  without  liquidation;  on 
liquidation  the  stockholder  would  receive  no  more  than 
before. 

Of  course  the  salability  of  the  new  shares  presents 
no  more  argument  for  the  existence  of  "income"  than 
does  the  salability  of  the  old  shares  at  an  increased 
price  because  of  the  accumulated  earnings  back  of 
them.  A  sale  in  either  case  would  have  the  same 
effect. 

If  one  had  9,000  shares  previously,  and  received 
4,500  additional  shares  through  a  'stock  dividend'  based 
on  surplus  accumulations,  he  of  course,  could  sell  any 
portion  of  the  total  13,500  shares.  And  if  he  sold 
4,500  of  the  13,500  shares  he  would  receive  the  equiva- 
lent in  cash.  But  he  could  have  realized  the  same 
amount  prior  to  the  'stock  dividend'  by  selling  3,000 
shares  of  his  original  9,000  shares.  His  intrinsic  in- 
terest is  the  same,  and  the  transaction  has  not  affected 
its  value. 

It  is  evident  that  Congress  has  suffered  from 
"polarization"  of  words  as  Judge  Dickinson  put  it  in 
Penn.  Mutual  Life  Ins.  Co.  v.  Lederer  (D.  C.  E.  D. 
Pa.  Feb.  4,  1918)  247  Fed.  559,  under  the  19 13  law. 

"As  readers  and  hearers  we  should  be  ever 
on  guard  to  prevent  our  minds  playing  any 
tricks  upon  us  by  being  affected  by  what  a  fa- 
mous writer  has  happily  called  the  'polariza- 
tion' of  words.  The  word  'dividends'  partakes 
somewhat  of  the  character  of  such  words.    To 


the  ears  of  those  fortunate  enough  to  be  placed 
within  hearing  distance  of  the  word,  it  has  a 
pleasant  sound  suggestive  of  the  'cutting  of  a 
ripe  melon'.  It  means  a  share  of  profits.  .  .  . 
Such  'dividends'  mean  merely  the  distribution 
of  the  whole  or  part  of  the  'net  income'  to  the 
happy  individuals  who  have  a  right  to  share 
in  it. 

As  a  consequence,  counsel  for  defendant 
manifest  an  inclination  to  dwell  upon  the  word 
'dividend',  and  to  speak  of  what  policy  holders 
receive  as  a  'dividend'.  Counsel  for  plaintiff 
show  a  tendency  to  avoid  the  use  of  the  term, 
or,  when  they  do  employ  it,  they  are  fond  of 
qualifying  it  by  a  slighting  phrase.  It  is  a 
'so-called'  dividend.  We  do  not  share  either  in 
this  fondness  for  or  aversion  to  the  use  of  the 
word.  It  is  clear  that  the  profit-sharing 
thought  is  altogether  an  applied  meaning, 
which  the  word  at  times  properly  has.  It  may, 
however,  be  properly  employed  when  the 
thought  of  profit  is  wholly  absent,  and  the  word 
has  its  etymological  meaning  of  a  unit  portion 
of  something  which  has  been  divided." 

The  Courts  have  always  recommended  that  mere 
appreciation  in  value  of  capital  assets  is  not  to  be  called 
income. 

"The  mere  fact  that  property  has  advanced 
in  value  between  the  date  of  its  acquisition  and 
sale  does  not  authorize  the  imposition  of  the  tax 
on  the  amount  of  the  advance.  Mere  advance 
in  value  in  no  sense  constitutes  the  gains, 
profits,  or  income  specified  by  the  statute.     It 


40 

constituted  and  can  be  treated  merely  as  in- 
crease of  capital." 

Gray  v.  Darlington,  15  Wall.  63,  66.* 

In  the  words  of  Mr.  Justice  McKenna  in  Lynch  v. 
Turrish,  247  U.  S.  221,  231,  speaking  with  approval  of 
Gray  v.  Darlington: 

"Indeed,  the  case  decides  that  such  advance 
in  value  is  not  income  at  all,  but  merely  increase 
of  capital  and  not  subject  to  a  tax  as  income." 

In  the  case  of  the  Baldwin  Locomotive  Works  v. 
McCoach  (3  C.  C.  A.  1915),  221  Fed.  59,  which  arose 
under  the  Corporation  Tax  Law  of  1909,  which  meas- 
ured the  tax  by  the  income  of  the  corporation,  the 
Court  said: 

"We  agree  with  the  District  Court  that  this 
increase  of  valuation  was  not  income  within 
the  meaning  of  the  statute.  Nothing  whatever 
was  added  to  the  corporate  property,  which  re- 
mained exactly  the  same  after  the  appraisement 
as  before.  The  only  thing  done  was  to  put 
upon  the  company's  books  an  expert  opinion 
that  certain  property  was  worth  a  certain  sum, 
and  this  can  hardly  be  said  to  be  income,  or 
even  gain,  in  any  proper  sense.     The  company 

*Under  the  British  Income  Tax  Act  (16  &  17  Vict.  c.  34)  it  is 
established  that  appreciations  in  value  of  capital  assets,  even  after  the 
realization  of  profits  by  sale,  do  not  constitute  taxable  income  except 
in  cases  of  transactions  by  dealers  or  other  persons  who  buy  and  sell 
for  purposes  of  profits.  Tebrau  (Johore)  Rubber  Syndicate,  Limited, 
v.  Farmer,  S.  T.,  5  Income  Tax  Cases,  658;  Stevens  v.  The  Hudson's 
Bay  Company,  5  Income  Tax  Cases,  424;  The  Assets  Company,  Lts.  v. 
The  Inland  Revenue,  Cases  in  the  Court  of  Session,  4th  Series,  Vol. 
24,  P.  578. 


41 

could  not  become  either  richer  or  poorer  by 
making  a  few  book  entries  that  merely  recorded 
a  new  estimate  of  how  much  it  was  worth." 

Exactly  the  same  situation  is  presented  when  the 
market  value  of  a  share  of  stock  increases  because  of 
accumulated  earnings.  Until  separation  takes  place, 
which  happens  when  a  cash  dividend  is  declared,  there 
is  no  taxable  income.  Again  the  courts  have  recog- 
nized that  such  appreciation  is  not  income,  for  nothing 
has  come  in,  part  of  which  can  be  taken  by  the  govern- 
ment for  revenue  purposes. 

In  Lynch  v.  Hornby,  247  U.  S.  339,  the  Supreme 
Court  said,  through  Mr.  Justice  Pitney,  in  reference 
to  the  undivided  surplus : 

"As  to  these,  however,  just  as  we  deem  the 
legislative  intent  manifest  to  tax  the  stock- 
holder with  respect  to  such  accumulations  only 
if  and  when,  and  to  the  extent  that,  his  interest 
in  them  comes  to  fruition  as  income,  that  is,  in 
dividends  declared"  (p.  343). 

Finally,  the  same  reason  exists  for  holding  that 
'stock  dividends'  shall  not  be  included  within  the  term 
"income".  It  is  not  necessary  to  show  again  what 
happened  when  the  Standard  Oil  Company  of  Califor- 
nia declared  its  'stock  dividend',  it  is  merely  sufficient  to 
show  that  plaintiff  has  not  received  anything  with 
which  to  pay  the  tax.  She  has  received  new  shares 
but  her  old  shares  represented  precisely  the  same  value ; 
in  fact  she  is  no  richer  at  the  end  of  the  year  than  at 
the  beginning;  and  as  in  all  the  cases  discussed  above, 
the  one  thing  necessary  has  not  taken  place — realiza- 


42 

tion  of  gain.  She  may  never  realize  any  gain.  Whether 
she  does  or  not  will  depend  on  the  ultimate  liquida- 
tion so  far  as  the  shares  themselves  are  concerned.  If 
dividends  are  received  on  the  new  shares,  so  that  she 
does  receive  gain  in  this  way,  she  will  be  taxable  on 
such  dividends.  But  until  that  point  is  reached  the  plain- 
tiff is  immune  from  taxation  under  an  income  tax  law. 
She  objects  to  the  payment  of  a  tax  as  having  received 
some  income  when  just  the  opposite  thing  has  hap- 
pened— she  has  been  definitely  assured  that  she  will 
not  receive  it. 

It  is  submitted  therefore  that  when  Congress  was 
authorized  to  tax  "incomes"  it  was  not  the  intention  to 
allow  it  to  tax  a  change  in  the  evidence  of  ownership 
which  is  all  that  a  'stock  dividend'  represents. 


POINT  V. 

judgment  should  be  rendered  overruling  the 
demurrer  and  awarding  to  the  plaintiff 
the  sum  sued  for. 

Murray,  Prentice  &  Howland, 

Attorneys  for  Plaintiff. 

Charles  E.  Hughes, 
George  Welwood  Murray, 

Of  Counsel. 


14  DAY  USE 

RETURN  TO  DESK  FROM  WHICH  BORROWED 

LOAN  DEPT. 

This  book  is  due  on  the  last  date  stamped  below,  or 

on  the  date  to  which  renewed. 

Renewed  books  are  subject  to  immediate  recall. 

• 

5>jan  *m  i  . 

REC'D  LD 

JAN  1 3  1957 

26Feb'57CF 

R£CT>  LD 

MAY  30  1957 

tMliliioKK56               UnivHS^rnia 

^ 


